Long arm of the law

Late last year, Mallesons Stephen Jaques, one of Australia’s “Big Six” law firms, announced a merger with King and Wood, one of China’s largest law firms. It was the first major combination of a top-tier Western law firm with a Chinese counterpart, and the agreement seemed to portend a wave of Sino-Western mergers. “Others are really looking to see what we do and will be following,” said Martyn Huckerby, a partner at Mallesons.

But while both Western and Chinese firms have good cause to seek mergers, their reasons differ, and finding a suitable match can be tricky. Western law offices want to expand their presence in China and co-opt the best local partners before their competitors can. Big Chinese law firms, meanwhile, seek to offer their clients better service abroad and one day join the global big leagues.

“It’s less a question of if [a wave of mergers will come], and more a question of when,” said Kent Zimmermann, a partner at Zeughauser Group, a firm which advises law firms on business strategy. “The conditions are right, but it’s hard to predict the timing.”

Come together

Globally, the legal industry is consolidating at an “unprecedented” pace, said Tony Williams, principal at UK-based legal consultancy Jomati. Law has historically been one of the most fragmented sectors of the global economy, with the bulk of profits clustered among a handful of top-shelf firms. However, an ongoing dry spell in the US and Europe is forcing smaller, less profitable firms to either close shop or be swallowed by their larger rivals.

“We’re seeing more merger activity and lots of firms opening new offices in various parts of the world,” Williams said. “It could be a very interesting [next] couple of years.”

Merging makes sense, because bigger is usually better in the business of law. Zimmermannn of the Zeughauser Group notes that bigger legal practices can devote more revenue to branding and poaching rival talent. And raising hourly billing rates across 4,000 lawyers brings in much more revenue than across 400 lawyers.

Western firms in China have even more incentive to merge. For one, Asia’s economic growth is creating big opportunities for the legal industry. Huckerby of Mallesons said that while foreign law firms have traditionally serviced foreign clients who are investing in China, firms are now shifting their focus to helping Chinese firms expand abroad.

China-based legal services do not yet generate much profit for big Western firms, but returns are projected to grow rapidly in coming years. In addition, law offices have to plan further in advance than most businesses. Zimmermann notes that many lawyers who made partner this year will be “in their most productive years” around 2025, meaning business decisions made now will affect earnings for decades to come.

The tipping point

By that time, international law firms may lose their current edge over their Chinese rivals. Since foreign outfits are not allowed to practice Chinese law, Western legal firms have focused on the lucrative business of advising clients on cross-border mergers and outbound acquisitions, while using local firms to do the nitty-gritty legal processing. Western firms have traditionally won market share by touting their superior quality, noted Andrew Halper, head of China practice at law firm CMS Cameron McKenna.

But local practices have been improving rapidly. Chinese firms are learning from international competitors, and young Chinese lawyers are increasingly educated and trained abroad. They return to China “with the acquisition of some of the toolkit Western law firms have that differentiates them,” said Halper. “Not all of it, but some of it. And you can get pretty far with some of it.”

It may only be a matter of time before Chinese law firms can go toe-to-toe with global firms, especially when clients factor in the lower prices of Chinese outfits and the restrictions on foreign firms in China. Western firms are therefore keen to co-opt their Chinese counterparts now, rather than watch them eat away at market share over coming decades.

Foreign firms would do well to move quickly. Zimmermann of Zeughauser Group pointed out that only a few Chinese firms are considered “top-tier.” Each successful Sino-Western hook-up leaves fewer single Chinese partners to tie the knot with; a few more big mergers could ignite a scramble for the rest. “These firms don’t want to be the last to the dance,” he said.

Two to tango

Why have more Sino-Western legal mergers not already happened? Chinese firms may be reluctant in part because mergers could actually decrease the volume of foreign business. By merging with an American or British company, the Chinese firm captures all of their partner’s referrals. But it also sacrifices referrals from competing Western law offices.

For example, insiders say big US and UK outfits had long courted King and Wood. The Chinese firm probably chose Mallesons not despite its limited presence in Anglo-Saxon markets, but because of it. Because American and British law firms do not view the Australian firm as a threat, they will likely continue sending referrals to King and Wood.

“That’s why it’s clever,” said Halper of CMS Cameron McKenna. “As soon as I read it I thought, now why didn’t I think of that?”

That said, some Chinese firms will still probably seek to join the global big leagues by allying themselves with big US and UK counterparts. While more legal work is shifting to Asia, the global legal market remains overwhelmingly concentrated in the US. Of the US$102 billion global legal industry, the US generates a whopping three-quarters.

The reason is America’s hyper-litigious judicial system. Punitive damages, treble damages, lack of “loser pays” rules and the prevalence of jury trials make the US legal system uniquely kind to plaintiffs.

“Many lawyers call the US the world’s hellhole litigation jurisdiction – meaning it’s a hellhole if you get sued,” said Zimmermann. The US legal system sucks in litigation from all over the world, creating an outsized market and “incentives for [law] firms that are not in the US to get a share of the American market if they want to be leaders on a global scale,” he said.

Long night

So far, Chinese firms’ forays into the American market have been limited to setting up offices and poaching talent. But Zimmermann said that they will eventually need to merge with a big British or American firm to win significant market share.

Yet even if Chinese firms look to tie the knot, trans-Pacific mergers will probably come only in fits and starts. Legal combinations are typically tough to pull off. Even within the same country, conflicting partner views, compensation schemes and client relationships often derail mergers. Cross-cultural deals add yet another layer of complexity that could obstruct Sino-Western legal mergers.

“I think it’s logical [that a push for tie-ups will occur], but that doesn’t mean it’s necessarily going to happen,” said Halper, adding that many in the industry will be watching King and Wood Mallesons as a test case. “The night is long; the dreams are many,” he said, quoting a Chinese proverb.

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